Keeping Its Powder Dry

06/30/2009 1:33 pm EST

Focus: GLOBAL

Paul Goodwin

Emerging Markets Specialist and Analyst, Cabot Heritage Corporation

Chinese milk powder producer American Dairy could pop higher once the correction has run its course, writes Paul Goodwin of Cabot China & Emerging Markets Report.

The steep market correction of the past week or so has dropped lots of stocks back to their 25-day moving averages and more than a few back to their 50-day moving averages and below. So, since Cabot's market timing indicators are still positive, this must be a great chance to pick up some real bargains on some great stocks, right?

Well, not so fast.

It's one thing to buy an individual stock that has just undergone an orderly pull back on reasonable volume.  But it's another thing entirely to buy into a significant market correction that has yet to put in a convincing bottom. 
 
I subscribe to the old stock market saying that you never try to catch a falling knife. Let caution be your guide in this kind of unsettled situation. 
 
My stock recommendation is American Dairy (NYSE: ADY), a Chinese producer of milk powder, soybean milk powder, walnut products, and other dairy stuff.

China isn't known as a big consumer of dairy goods. Many Chinese find cheese distasteful and just don't enjoy yogurt, buttermilk, and the rest of the milk-based foods that delight Westerners. But that's changing…a little. The Chinese are finding a place in their child-rearing regimen for milk-based infant formula, and the potential is enormous.

The company has been around since 1985, and its product mix—where do walnuts fit in with milk products, you might ask—reflects a kind of opportunistic management style that takes opportunities where it finds them.

It took two successive quarters of amazing results to put ADY on investors' radar screens. In [the fourth quarter of 2008], the company turned in an astonishing 1,550% jump in earnings on just a 25% gain in revenues. Then, just to prove that wasn't a fluke, the company's [first-quarter] report revealed a 278% earnings jump on a 191% boost in revenues. After-tax profit margin for [the first quarter] was a respectable 24.4%.

The milk business in China has had to do a lot of fence mending following last year's melamine-tainting scandal. American Dairy came through that with its record clean as a whistle and growth has been excellent since then.

The stock bottomed at $9 in March, and since then has gone off like a rocket, soaring to $44 two weeks ago. ADY has been correcting with the market, but it's holding above its 25-day moving average, which is right at $38. [Shares closed at $40.81 in New York Monday—Editor.] The stock will need to settle down a little and build a new base for further advances. But you don't find many stocks that turn in nearly five-bagger performance in less than six weeks. It's worth a look.

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